Rent capping may receive a warm welcome from generation renters but what are the implications for investors in the Private Rented Sector and burgeoning Build to Rent market? We examine the capricious situation in Germany’s capital – and look at other major cities around world.
In June 2019, the Senate of Berlin released the main policies that will constitute new state legislation to regulate rent levels for 1.5 million apartments. By setting an upper limit on rent prices in existing and future lease agreements, introducing a rent freeze, and imposing financial penalties in the case of a transgression, the Senate aims to respond to popular dismay regarding rising rents.
Based on the Senate’s announcement on October 22, 2019 and as the plans currently stand, it will come into effect on January 1, 2020 and expire in five years. The regulations will have retroactive effect reaching back to June 18, 2019 to counteract attempts at last-minute rent increases.
As plans currently stand, it shall come into effect on January 1, 2020 and expire in five years. The regulations shall have a retroactive effect reaching back to June 18, 2019 to counteract attempts at last-minute rent increases
The desire to regulate rent levels in Berlin is, apparently, not restricted to housing. On August 13, 2019, the Senate announced that it had submitted a legislative proposal to the Bundesrat, the German Federal Council, to amend the German Civil Code and enable federal states to introduce a cap on the rents of commercial premises in strained markets.1 This regulation aims to strengthen small business owners in city centers who, facing rent increases, have instead established businesses in outer boroughs.2
This is not the first attempt of the Senate to introduce rent caps on commercial rents. In May 2018, it submitted a similar initiative to the Bundesrat3 that, in turn, released a resolution in October 2018 in which it appealed to the German government to take action against the ousting of small and middle business owners.4
Under German law, parties of commercial leases are considered less vulnerable than tenants in residential lease agreements, so the German government has not seen it necessary to reform the German Civil Code.5 It’s unlikely the government has changed its stance.
Rent freeze and rental caps
In line with the draft legislation and as announced in key points preceding the draft, landlords will be prohibited to increase net rents (Nettokaltmiete) regardless if the contracting parties have agreed on a stepped or indexed rent. This rent freeze will have a retroactive effect, starting June 18, 2019.
The draft also includes a chart in which the upper limit for the price per square meter has been defined. The caps on prices are not influenced by the location in which a property is situated but rather by the year in which the apartment was ready for occupancy and by its facilities, namely central heating and bathroom. The rental caps also apply to lease agreements concluded after June 18, 2019. Starting in 2022, a yearly rent increase of 1.3% will be legal, provided the increased rent does not exceed the upper limit defined by the legislation.
The draft legislation provides an additional instrument to that introduced by the federal legislator to regulate rent increases following modernization measures. As a result, the rent caps can only be exceeded by EUR 1.40 per square meter if the modernization measures were carried out in the 15 years preceding January 1, 2020. For modernization measures carried out after that date, the rent increase can only exceed the upper limit set out in the legislation by EUR 1 per square meter. Permission from the district administration is required in both cases.
Finally, nine months (at the earliest) after the law becomes effective, tenants can submit an application for rents to be decreased if they exceed 20% of the cap set by the legislation and a tolerance threshold depending on the location of the property.
Applying the brakes on rising rents
Solving the housing shortage and providing affordable housing for citizens of German cities have been on the political agenda for years. The Mietrechtsnovellierungsgesetz (MietNovG) of April 2015 introduced the Mietpreisbremse into the German Civil Code: an instrument supposed to apply the brakes on increasing housing rents.
Pursuant to Section 556d(2) of the German Civil Code, the federal legislator granted state legislators the power to determine which sectors are to be considered as strained residential markets. Section 556d(1) of the German Civil Code prohibits the landlord of aproperty in a strained residential market, at the time of the conclusion of a new lease agreement, to demand from a future tenant a rent exceeding 10% of the rent customary in the locality. With this new instrument, the legislator aimed to impede landlords from increasing the rent in the case of subsequent rental.
The Mietrechtsanpassungsgesetz (MietAnpG) of December 2018 introduced further disclosure requirements on the rent claimed under the previous lease and the modernization measures undertaken in previous years. In recent months, the German federal government announced this instrument will remain in force until 2025.6
It remains contentious whether the Senate of Berlin has the competence under the German Constitution to introduce additional instruments to the Mietpreisbremse and to the capping limit defined in the German Civil Code7 through state legislation. The majority of critics argue that rent regulations are a matter of civil law, a field that states can only regulate if the federal legislator has abstained to.8
Even if the Senate of Berlin had the competence to enact such a state legislation, its policies remain controversial in multiple aspects. The German Bar Association (Deutscher Anwaltsverein) has been scathing, not only regarding the scope of the policies, which would apply to existing lease agreements concluded in compliance with the German Civil Code, but also the general assumption that the entire city represents a strained market.9
Although the Federal Constitutional Court confirmed in its decision of July 18, 2019 that the Mietpreisbremse is consistent with the constitution,10 it remains unclear whether the same can be said regarding planned legislation by the Senate of Berlin.
In its decision, the Federal Constitutional Court affirmed that renting one’s property is an income stream protected by Art. 14 (1) of the German Constitution.11 To reap the highest possible profit, however, was not protected by the property guaranty.12 Nevertheless, the rent regulations would constitute an encroachment on the right to property of the landlords if they would lead to losses in the long run or would endanger the substance of the property as such.13
Although the Senate of Berlin has taken these circumstances into account by allowing landlords under the draft legislation to be granted, in such cases, an exemption due to hardship, it could be argued that landlords in general will incur a severe loss in cases of inflation or when carrying out necessary modernization measures at costs they will not recover later due to rental caps defined in the legislation.
This latter point could prove critical, especially given that pursuant to Section 556f of the German Civil Code and as confirmed by the Federal Constitutional Court, extensively modernized apartments are not subject to the rent regulations under the German Civil Code.14 Eventually, only the German Federal Constitutional Court will be able to provide clarity.
Looking to other cities around the world, it’s also clear the wave of new rent regulations cannot be considered as a specifically German phenomenon.
Rent regulation in New York State began during World War II when the federal government declared a national state of emergency and imposed nationwide price controls. It was not until 1969, however, that the City of New York established Rent Stabilization laws intended to provide flexibility and a market-friendly approach to housing. This allowed landlords to increase rents annually while protecting tenants’ rights to remain in their apartments.
In the decades following, these aws were expanded to include regulations such as the placement of moderate caps on landlords’ ability to pass the costs of individual apartment improvements and major building capital improvements onto tenants. During this time, these expansions were not generally viewed by landlords, developers and investors as a significant impediment to investing in the city’s residential market.
In June 2019, under Governor Andrew Cuomo, the list of rent reforms enacted included:
Individual Apartment Improvements (IAIs) – Only 1/180th of the amount a landlord spends on IAIs (which improvements are not to exceed USD 15,000 within a 15-year period) may be transferred onto the tenant’s rent (for buildings with 35 or more units; for buildings with fewer than 35 units this amount is 1/168th). Note that these increases may only be in effect for a period of 30 years, at which time the rent must revert back.
Major Capital Improvements (MCIs) – regardless of the amount spent on MCIs, a landlord must cap all rent increases at 2% of a tenant’s rent, which increases are to be amortized over a period of 12.5 years (for buildings with 35 or more units; for buildings with fewer than 35 units the amortization period is 12 years). Note that these increases may only be in effect for a period of 30 years, at which time the rent must revert back.
Vacancy Bonuses – whereas landlords were previously able to raise rents as much as 20% each time a unit was vacant, the Vacancy Bonuses were eliminated.
Condo/Co-op Conversions – a minimum of 51% of tenants in occupancy must agree to purchase the apartments before a conversion plan can be effective, and ‘Eviction Plans’ have been eliminated.
Elimination of the ‘Sunset Provision’ – the new regulations are permanent unless revoked by the state legislature, unlike the prior laws that expired every 4-8 years, so eliminating uncertainty for tenants and decreasing the value of large contributions to politicians controlling rent regulations.
The constitutionality of these laws is questionable, as they place the financial burden of providing housing on the private sector. With the new laws facing numerous legal challenges, it’s also useful to consider their fundamental effectiveness and to what extent they can achieve their intended purpose. Removing incentives for landlords to renovate buildings lowers their net operating income and leads to worsened housing conditions. As a result, property values decrease (as does the city tax base) and investors look outside the state for more profitable opportunities. In recent years, retail vacancies have multiplied in New York City and some city council members are arguing for the enactment of commercial rent control, which would trigger additional legal challenges by the landlords affected.
With the UK capital facing a housing crisis, the mayor Sadiq Khan appealed to the government in 2019 to introduce controls in the Private Rented Sector. This sector was deregulated by the Housing Act of 1980, which was replaced by the Housing Act of 1988.15 With Sadiq Khan up for re-election in 2020, he has chosen rent controls as a central pillar to win over voters. One-in-four Londoners rent privately and on average spend more than 40% of their monthly pre-tax income on rent, so this issue is bound to find support. But will this help or hinder London’s current housing crisis?
“The demand for housing shows that Germany remains a market in which one can invest and build… investing in commercial premises remains interesting.”
It depends on which type of rent control is proposed. Fixing rental rates to inflation indexes (such as the Retail Price Index, or RPI) would not necessarily be unattractive to institutional investors seeking secure income streams. However, proposals from the Mayor’s office seem to go way beyond this and seek to control initial starting rents and to lower rents in certain areas where it’s deemed to be too high. If this is the case, it is hard to see how this wouldn’t have a negative effect on the burgeoning institutional Build to Rent (BtR) market and the wider Private Rented Sector.
Rents at below market levels would restrict supply, as landlords are not incentivized to bring their properties to market. It will also probably lead to a lack of investment into existing stock as there is no incentive on a landlord to redecorate and improve properties as they would reach a ceiling for the level of rent they could charge. It is also notoriously difficult to police: the infrastructure to map and control all rents in the private and public sectors simply isn’t there. It would appear far more beneficial to increase the supply of properties available in all tenures through public land and fiscal support, as the crisis isn’t limited to rental property alone.
Limits on how much landlords could charge tenants for rent were first imposed in Paris in 2015. This was overturned in 2017 on the grounds it should apply throughout the region. Following new legislation in October 2018 (the Elan law), cities were granted the right to impose rent control under certain conditions to protect tenants and create more affordable housing. This law also introduced simplifying standards to help build more homes faster and to facilitate the conversion of empty offices into homes. In Paris, citywide rent controls came into effect on July 1, 2019. Limits will only apply to new leases.
In Austria, the Rent Control Act (Mietrechtsgesetz) was introduced in 1919, and now has a seemingly endless amount of amendments. The core principle is that rents were frozen at the pre-World War I level with a broad range of rights to take over the lease agreement including low rent for certain people related to the tenant. Rent level was also capped.
In the years following, amendments changed some of the most restrictive provisions but limits remain on certain rents, with increases and reductions based on, for example, location, an apartment’s position in a building, technical equipment in the building, and so on. Provisions are complicated and require a caseby-case review. Austria’s Chamber of Labour and the City of Vienna provide a calculator so every tenant can check whether their rent is in line with the legal provisions.
Conclusion: meeting the demand for housing
The question remains as to whether setting a ceiling on rent prices can be considered an efficient solution to a housing shortage.
Through the introduction of the Mietpreisbremse in Germany, the growth in rents has slowed.16 Although Berlin has seen an increase in the construction of apartments, the 20,000 that need to be built each year to satisfy market demand remain, for the moment, out of reach.17 The pragmatic way to approach this issue is for Germany’s government to take measures to facilitate the construction of property, such as amending building laws and removing bureaucratic obstacles.18
The demand for housing shows that Germany remains a market in which one can invest and build. Even if the Senate of Berlin comes through with its state legislation, the scope of its policy does not encompass newly built housing. This represents an opportunity, considering the rising population and the housing shortage. Indeed, investing in commercial premises remains interesting, as the cities in Germany will expand and reform of the law remains unlikely.